The Treatment of corporate tax attributes in Group Restructurings...

The Treatment of corporate tax attributes in Group Restructurings -

An analysis for corporations resident

in Austria, the United Kingdom and the Grand Duchy of Luxembourg in light of

recent ECJ judgements

MA Taxation 2012/3 Dissertation S1014 / 0944343

TABLE OF CONTENTS

1 ABBREVIATIONS .......................................................................................................... 4

2 INTRODUCTION ............................................................................................................ 6

2.1 Background ......................................................................................................................... 6

2.2 Aim and delimitations ..................................................................................................... 6

2.3 Structure of Paper ............................................................................................................ 8

3 DOMESTIC FRAMEWORKS FOR MERGERS .......................................................... 9

3.1 Introduction ....................................................................................................................... 9

3.2 Corporate Laws on mergers .......................................................................................... 9

3.3 Tax Laws on mergers .....................................................................................................11

3.3.1 Austria ...................................................................................................................................... 11

3.3.2 Luxembourg ........................................................................................................................... 14

3.3.3 United Kingdom .................................................................................................................... 16

3.4 Common Themes and Potential Problems ............................................................18

4 EU LEGAL FRAMEWORK FOR MERGERS ............................................................ 21

4.1 EU Law ................................................................................................................................21

4.2 The Merger Directive ....................................................................................................23

4.3 The Procedure .................................................................................................................24

4.4 Conclusion .........................................................................................................................25

5 ECJ CASE LAW ON LOSS UTILISATION ................................................................ 26

5.1 ECJ cases on cross border loss utilization in group mergers ..........................26

5.1.1 Marks & Spencer .................................................................................................................. 27

5.1.1.1 The facts of the case ..................................................................................................................... 27

5.1.1.2 The ECJ judgment .......................................................................................................................... 27

5.1.1.3 The Marks & Spencer legacy - The final losses doctrine .............................................. 29

5.1.2 A Oy ............................................................................................................................................ 30



5.1.2.2 The ECJ judgment .......................................................................................................................... 31

5.1.2.3 A Oy - The impact on future case law ................................................................................... 33

5.2 ECJ on Tax Avoidance for loss utilization in mergers ........................................34

5.2.1 Foggia ........................................................................................................................................ 34


5.2.1.2 The ECJ judgment .......................................................................................................................... 35

5.3 Resulting trends in ECJ case law ................................................................................36

6 CONCLUSION ............................................................................................................... 37

REFERENCES ...................................................................................................................... 39


1 ABBREVIATIONS

AB Swedish limited liability company (Aktiebiolag)

AG Austrian public limited liability company (Aktiengesellschaft)

AG Advocate General

AktG Austrian Corporate Law for public limited liability company

BMF Austrian Ministry of Finance (Bundesministerium für Finanzen)

CA The Companies Act

CTA Corporation Taxes Act

ECJ Court of Justice of the European Union (in European literature often abbreviated to CJEU)

EStG Austrian Income Taxes Act (Einkommenssteuergesetz)

EU European Union

EVL Finnish Act on Business Taxation (Elinkeinoverolaki)

FSMA 2000 Financial Service and Markets Acts 2000

GAAR General Anti-Abuse Rules

GmbH Austrian private limited liability company (Gesellschaft mit beschränkter Haftung)

GmbHG Austrian Corporate Law for private limited liability company

HMRC Her Majesty's Revenue and Customs (UK)

IBFD International Bureau of Fiscal Documentation

ICTA UK Income and Corporations Taxes Act

KStG Austrian Corporation Taxes Act (Körperschaftssteuergesetz)

LIR Luxembourg Tax Rules (Loi de l’impôt sur le revenue)

LSC Luxembourg law on commercial companies (loi sur les societies commerciales)

MS Member State

PE Permanent Establishment

SA Luxembourg public limited liability company (Société Anonyme)

SarL Luxembourg private limited liability company (Société a responsabilité limitée)

SCA Luxembourg Partnership limited by shares (Société en commandite par actions)

StAnpG Austrian Adjustment Taxes Act (Steueranpassungsgesetz)

StrukAnpG Austrian Infrastructure Adjustment Taxes Act (Strukturanpassungsgesetz)


TAAR Targeted Anti-Abuse Rules

TCGA UK Taxation of Capital Gains Act

TFEU Treaty for the Functioning of the European Union

TIOPA UK Taxation (International and other Provisions) Act

TVL Finnish Income Tax Act (Tuloverolaki)

UGB Austrian Corporate Law (Unternehmensgesetzbuch)

UK United Kingdom

UmgrStG Austrian Corporate Restructuring Taxes Act (Umgründungssteuergesetz)


2 INTRODUCTION

2.1 Background

Corporate groups consist of a number of companies that are often independent legal

entities, however despite this legal separation, in economic reality part of one unit.

Each entity may be subject to separate corporate and tax rules in its country of

incorporation. Optimizing the corporate legal entity structure by terminating loss-

making activities and combining entities can achieve increased profitability and

realize cost savings.

For domestic reorganizations, most jurisdictions provide favorable national treatment

for groups of companies, by providing for tax neutral legal entity restructurings within

a group. Crossborder reorganizations across multiple jurisdictions and tax systems are

more complex and do not tend to award the same benefits for group mergers. They

often result in unused losses or increased tax liabilities. In addition to the often

lacking domestic rules for cross border mergers, these transactions are also often

subject to European Union (“EU”) law. EU law does not explicitly harmonize direct

Taxation, so the case law of the ECJ provides guidance in its judgments. The resulting

uncertainty for corporates as to whether losses can be ‘merged’ makes decisions on

legal entity restructurings difficult and may limit the ability to choose the most

efficient corporate structure.

2.2 Aim and delimitations

The aim in this paper is to establish to what extent rules in domestic tax law provide

for tax neutrality in mergers and whether they allow for internal and cross border loss

set off. In this paper, an overview of the relevant rules for domestic and European


group mergers in three European countries - Austria, the Grand Duchy of

Luxembourg and the United Kingdom – will be given, drawing out similarities and

potential problematic areas. All three jurisdictions allow tax neutral restructurings of

some kind, which raises the question as to what extent losses can be ‘mergable’.

ECJ case law is analysed with the aim to furthermore establish whether the ‘final

losses doctrine’ and ‘valid commercial rationale’ discussion by the ECJ has been

shaping the national laws on loss utilisation in Austria, Luxembourg and the United

Kingdom. In the analysis of the case law, a natural area of focus will be on the recent

emphasis for loss availability in a crossborder merger - the concepts of when losses

are ‘final losses’ and when a restructuring is undertaken for a ‘valid commercial

rationale‘. These are important concepts in the ECJ’s jurisprudence as they ensure

losses can no longer be used in the other Member State and no abuse is suspected, in

which case an exceptional requirement for the host state to take losses into

consideration exists.

The analysis is limited to the merger in groups of companies and their subsidiaries in

the EU; rules on group consolidations and distributions will not be considered. The

ECJ case law analysis will focus on cases with regard to final losses of subsidiaries,

discussions of on-going losses or cases regarding foreign PEs will only be taken into

consideration where they add an important aspect to the discussion.


2.3 Structure of Paper

Chapter 3 will review the three respective domestic corporate law framework for

mergers, explore their definition of merger and give an overview of the national tax

rules, including the approach to anti-abuse rules. The chapter ends with an overview

of common themes and potential problems.

Chapter 4 gives an introduction to applicable EU laws, their mechanics and the

fundamental freedoms. After an overview of the procedure of referring cases to the

ECJ, it gives a summary of the increased role of the ECJ in defining the boundaries

for harmonisation in the area of direct taxation in the EU.

Chapter 5 analyses how the line of ECJ case law on loss utilisation and anti-abuse

scenarios has developed. The review here focuses on the ECJ judgement in Marks &

Spencer and A Oy in the areas of loss utilisation and Foggia as an example of anti-

abuse discussion as they constitute the most recent and most relevant decisions. The

chapter concludes with summarising the requirements for cross-border loss utilisation

in a group merger and potential open questions.

Chapter 6 contains a conclusion for the whole thesis by answering the questions

raised at the outset and pointing to current developments.


3 DOMESTIC FRAMEWORKS FOR MERGERS

3.1 Introduction

To understand the different tax rules for mergers, a starting point will be the different

concepts in the national corporate law of the three countries. For the purposes for this

paper, the term ‘merger’ will be used to describe what is generally considered a legal

merger1. Essentially where a corporation (the transferring entity) is legally merged

with another corporation (the receiving entity), the transferring entity’s assets and

liabilities are taken over by the receiving entity and the transferring entity then ceases

to exist without going into liquidation.2

One of the main challenges with this topic is that the definition of merger and its

subsequent tax treatment depend entirely on the respective jurisdiction’s corporate

law. Each of the jurisdictions has its own definition of merger. The corporate law in

both Austria and Luxembourg provides specifically for a merger by absorption3, the

UK however does not.

3.2 Corporate Laws on mergers

In Austria, corporates are subject to the general rules of the Unternehmensgesetz

(“UGB”), which are then supplemented by specific rules depending on the type of

corporation. For private limited companies (GmbHs), and public limited companies

1 This understanding is in line with the definition of merger in Art.2 of the Merger Directive (Directive 90/434/EEC on a common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States).

2 Also see the European Court of Justice’s (“ECJ”) decision in Punch Graphix (C-371/11), which confirmed that the dissolution of a company through a merger by acquisition cannot be equated to a liquidation.

3 In both countries, this in addition to a merger by incorporation, which is also explicitly stipulated in the corporate and tax laws.


(AG)4 the rules on mergers by absorption (“Verschmelzung durch Aufnahme”) are in

§ 96, Abs.1 GmbHG5 and § 219, Abs 1 AktG6. As a result of these rules, a merger by

absorption leads to universal succession (‘Gesamtrechtsnachfolge’) by operation of

law in exchange for shares, i.e. a full assignment of all assets, rights and liabilities

from the transferring company to the receiving company.

In Luxembourg, the loi sur les sociétés commerciales 7 (law on commercial

companies, “LSC”) governs the legal aspects of domestic and cross border mergers

for corporates8 (Section XIV – Des Fusions9). A merger by absorption is defined as

“an operation whereby one or more companies, dissolved but not liquidated, pass on

all of their net assets (assets and liabilities included) to an existing or new company.

Their contributions are remunerated by the allocation of shares in the pre-existing or

new company and, where applicable, the payment of a balancing cash adjustment that

does not exceed 10 % of the nominal value of the units or shares distributed.” 10

4 Applicable corporate and tax laws are driven by the legal form and seat (administrative centre, “Verwaltungssitz” - as per § 10 Bundesgesetz vom 15. Juni 1978 über das internationale Privatrecht (“IPR-Gesetz”), this will in most cases be the same as the place of effective management (“Ort der Geschäftsleitung”), which governs the jurisdiction to tax under § 27, Abs 2 Bundesabgabenordnung (“BAO”). See http://www.jusline.at/27_BAO.html on 20.5.2013.) of the company in question (See Steuerrichtlinien: Rz 28-30 UmgrStR. See https://findok.bmf.gv.at/findok/link?gz=%22BMF-010203%2F0560-VI%2F6%2F2011%22&gueltig=20111115&bereich=rl on 20.5.2013.)

5 “Gesellschaften mit beschränkter Haftung können unter Ausschluß der Abwicklung verschmolzen werden. Die Verschmelzung kann erfolgen durch Übertragung des Vermögens einer Gesellschaft oder mehrerer Gesellschaften (übertragende Gesellschaften) im Wege der Gesamtrechtsnachfolge auf eine andere bestehende Gesellschaft (übernehmende Gesellschaft) gegen Gewährung von Geschäftsanteilen dieser Gesellschaft (Verschmelzung durch Aufnahme) […]” at http://www.jusline.at/96_Begriff_der_Verschmelzung_GmbHG.html on 10.8.2013.

6 “Aktiengesellschaften können unter Ausschluß der Abwicklung verschmolzen werden. Die Verschmelzung kann erfolgen durch Übertragung des Vermögens einer Gesellschaft oder mehrerer Gesellschaften (übertragende Gesellschaften) im Weg der Gesamtrechtsnachfolge auf eine andere bestehende Gesellschaft (übernehmende Gesellschaft) gegen Gewährung von Aktien dieser Gesellschaft (Verschmelzung durch Aufnahme) […]” at http://www.jusline.at/219_Begriff_der_Verschmelzung_AktG.html on 10.8.2013.

7 Initially dating from 10 August 1915 and as amended in 2011.

8 The corporate law applies to a range of commercial companies, including the S.A., S.a.r.L.and the SCA. All these companies limited by shares are also subject to corporate income tax.

9 See http://eli.legilux.public.lu/eli/etat/leg/loi/1915/08/10/n1 on 10.8.2013.

10 See http://www.guichet.public.lu/entreprises/en/fiscalite/developpement-restructuration/acquisition-societes/fusion/index.html, on 14.5.2013.


In the UK, a very different approach is taken. Company law does not specifically

provide for a ‘statutory’ merger or merger by fusion. Instead, a business combination

can be achieved through a share exchange 11 combined with a subsequent group

reorganization or by transferring the business to the receiving company in exchange

for shares in that company (Scheme of reconstruction). These transactions do not

automatically result in only one surviving company 12 and therefore require a

subsequent liquidation of the transferring company.

Having three different corporate law approaches to the legal construct available for

business reorganization, helps to understand the different national tax rules for

mergers.

3.3 Tax Laws on mergers

3.3.1 Austria

In Austria, the process of legally and commercially combining the assets and

liabilities of the transferring company and the receiving company is termed

‘Verschmelzung’ (amalgamation). In general, all transactions are subject to the main

principle of Austrian taxation, the ‘Tauschgrundsatz’ § 6 Z 14

Einkommenssteuergesetz (“EStG”), whereby all exchanges should be valued at the

common value of the asset. Austrian tax law, jurisprudence and case law differentiate

11 See Harris (2013), p.542.

12 The only form of universal succession in UK company law is achieved through schemes of arrangement, Companies Act 2006, Parts 26 and 27 (ss. 895-941). Also see http://www.hmrc.gov.uk/manuals/insmanual/ins3101.htm, on 16.5.2013. These are available either formally under both The Companies Act (Section 425 CA 1985 for preserving the business of a company to be carried on by substantially the same persons) and the Insolvency Act (Sections 110, 167 to 169 IA 1986 for companies in liquidation whose business is transferred to another company) or as informal schemes. They will result in the liquidation of the ceasing company post transfer of all or part of the undertaking. As the formal requirements are rather cumbersome, schemes of arrangements are seldom used.


combining entities, whilst maintaining essential business activities13, from a disposal

of assets and liabilities. As a result, mergers of private and public limited companies

are governed by the specific - and mandatory 14 – rules of § 1 Abs 1 Z 1

Umgründungssteuergesetz15 (“UmgrStG”)16.

Tax neutrality is achieved by valuing the transferred assets and liabilities at their

historic cost base in the receiving company (“Buchwertfortführung”). Consequently,

unrealised gains and losses (“stille Reserven”, “stille Lasten”) are only triggered at a

subsequent revaluation 17 or disposal, provided the jurisdiction’s ability to tax

subsequent gains is not diminished. These rules are limited by § 24 Abs 2 UmgrStG

to a scenario where the ‘jurisdiction to tax’ is changing and a potential reduction of

the Austrian tax base would occur.

The most significant exceptions to achieving tax neutrality occur in cases of abuse.

Where substance and legal form differ, economic substance18 is taken as the basis for

calculating the tax liability. Where the sole motivation of a transaction is found to be

13 This applies as long as the merger is indeed a reorganisation of business activities and assets under a new legal form and ownership. See later discussion of cases of abuse.

14 § 1 Abs 3 UmgrStG. The UmgrStG applies mandatorily but also exclusively to all cases of amalgamation with no ability to choose other, more general, tax rules. See Doralt/Ruppe I8 pp.382 et seq.

15 Applicable to mergers after 31.12.1991 (BGBl 1991/699). Prior to that the Strukturverbesserungsgesetz (BGBl 1969/69) allowed adjusting the legal form for commercially required reorganizations whilst avoiding the realization of profits as would have been triggered in a sale.

16 See § 20 Abs1 KStG, rather than applying the liquidation rules under § 19 Körperschaftssteuergesetz (“KStG”).

17 Under Austrian accounting rules (§ 202 Abs 2 Unternehmensgesetzbuch (“UGB”) (2013), amalgamations result in a) a choice whether to continue the cost base of the assets or apply current value, and b) in case of a continuation of the cost base, a limitation of backdating the merger by a maximum of 9 months prior to registration with the companies register (“Firmenbuch”). See Doralt/Ruppe I8 pp.385 et seq. Where the UmgrStG applies, the “Massgeblichkeitsprinzip”, a rule under which accounting results have to be carried into the tax accounts, does not apply and the tax accounts may diverge from the financial accounts. For a merger, final accounts of the ceasing company need to be prepared (“Schlussbilanz”) as well as combined accounts of the two companies after the merger (“Verschmelzungsbilanz”). The rules of the UmgrStG apply irrespective of whether there is an election to mark to market under the accounting rules.

18 See Rosenberger, Stürzlinger (2011), p.111 and § 21 Abs.1 BAO.


the reduction or elimination of a tax obligation 19 , § 44 UmgrStG negates the

application of the UmgrStG for both domestic and cross border transactions. Cross

border mergers are tested for abuse under the anti-abuse articles of the Merger

Directive20. In both cases the benefits of the UmgrStG are no longer available and the

liquidation rules of § 20 iVm § 19 KStG 1988 apply, resulting in the realization of

unrealized gains and losses.

In Austria, losses incurred by resident companies are generally available for

indefinite21 carry forward22 (§ 18 Abs. 6 & 7 EStG 1988). For both domestic and

cross border EU mergers, § 4 UmgrStG23 provides that unutilised losses connected

with either of the companies be transferred to the receiving company. They are

subsequently available for future set off against profits as long as the assets relating to

the losses are still in existence on the merger date (“objektbezogener

Verlustvortrag”)24.

The loss carry forward is limited by § 8 Abs 4 Z 2 KStG25 in cases of trading loss

companies (a circumstance considered abusive and termed ‘Mantelkauf’ 26 ). The

19 As per the Austrian General Anti-Abuse Rule (‘GAAR’) of § 22 BAO. For a recent analysis see Kofler, Austria in IFA (ed.), Tax treaties and tax avoidance: application of anti-avoidance provisions, vol 95a, Cahiers de droit fiscal international, pp.100 et seq. (2010)

20 Art. 15 of the EU Directive 2009/133/EG.

21 As introduced by the Strukturanpassungsgesetz 1996 (“StrukAnpG”).

22 No provisions for loss carry back exist under Austrian tax law. See Achatz, p.294.

23 Carrying forward the losses requires a) accounting for assets and liabilities at historic cost (§ 4 Z 1 lit a UmgrStG), b) assets relevant to losses being in existence at merger date (§ 4 Z 1 lit a UmgrStG), c) assets being transferred is comparable to assets at time of incurring losses (§ 4 Z 1 lit c UmgrStG), d) no limited for connected companies (§ 4 Z 1 lit d UmgrStG) and e) not abuse (‘Mantelkauf’ § 4 Z 2 UmgrStG).

24The requirement for transferred assets and liabilities to be connected with the losses is similar to the requirement of Article 4 (2) Merger Directive. See § 4 Abs Z lit d UmgrStG for rules regarding previous revaluations of group equity holdings.

25 See Achatz p.299 et seq. for more background.

26 See also SWK Heft-Nr 9/1995, 249 and SWK Heft-Nr 9/1996, 191. As the rules on ‘Mantelkaufgeschäfte’ are ambiguous, there are numerous discussion and cases on this topic debating what constitutes a continuation of comparable business assets and activities, for example SWK Heft-Nr 23/2003, 580 Norbert Schrottmeyer: Umgründungssteuerrecht: Ein Fall aus der Praxis - Mantelkauf und Verschmelzungen, Zusammenspiel von § 8 Abs 4 Z 2 KStG und § 4 UmgrStG.


circumstances of a ‘Mantelkauf’ transaction are suspected in cases of significantly

changing a) the character of the business in a merger situation, b) substantial changes

to the organizational structure and c) to the business scope of the company. As these

facts would leave the business considerably changed they result in the non-

transferability of the losses in a sale.27

3.3.2 Luxembourg

In Luxembourg, specific tax rules cover legal entity restructurings including the

combination of two entities through a merger by absorption. The rules of Art. 169-

172bis Loi de l’impôt sur le revenu (“LIR”) provide for the universal transfer of the

net assets 28 of the transferring entity to the receiving entity, the automatic

dissolution 29 of the transferring entity and the remuneration for the transferring

entity’s contributions. Roll over relief is provided for both domestic and cross border

mergers. The benefit of tax neutral mergers are only available where the receiving a)

company is a fully taxable Luxembourg resident taxpayer30, b) the remuneration31 is

limited to a small cash portion32 / exchange for shares and c) the receiving company

continues to account33 for assets and liabilities at historic cost base34 to ensure any

hidden reserves stemming from unrealised gains and losses will be taxed in the future.

27 More on the likely circumstances constituting a ‘Mantelkauf’ in Petritz, Ressler p.193 et seq.

28 Termed ‘transmission universelle de patrimoine’ and governed by art.171 al.I LIR, at http://www.impotsdirects.public.lu/legislation/LIR/Loi_modifi__e_du_4_d__cembre_1967_concernant_l_imp__t_sur_le_revenu_-_texte_coordonn___au_1er_janvier_20131.pdf on 14.5.2013.

29 See art.170 al.Ier LIR.

30 Art.170 al.2 LIR.

31 Art.170 al. 2 no I LIR. A merger premium can be calculated by comparing the value of the net assets (‘la valeur nette comptable de l’actif social transféré’) to the total remuneration obtained (‘la rémunération obtenue pour l’actif social’), see Steichen (2004) pp. 446 et seq.

32 Not exceeding 10% of the nominal value of shares.

33 Art.170 al.4 LIR.

34 See also Steichen (2004) pp.446 et seq.


Tax-neutral mergers are possible for domestic or EU reorganisation if Luxembourg

retains the right to tax any deferred gains at the time of realisation35, usually implying

some presence, i.e. a permanent establishment, remaining onshore in an outward

merger. Where the receiving entity held a participating interest of 10% or more in the

transferring entity, Luxembourg applies a preferential regime. The benefit provided

from the Parent Subsidiary directive is extended to the capital gain from the share

exchange and is treated as if it had been a dividend. 36

Only the entity that suffered the losses can carry them forward. Art.114 LIR provides

that Luxembourg resident companies can carry forward losses without time limits and

offset them against future profits, subject to certain conditions37. In a merger, this

means that the receiving entity cannot carry forward any losses incurred by the

transferring company 38 . By contrast, the same does not apply to a change in

shareholder39. In cases of suspected abuse, the tax authorities can refuse the carry

forward of the losses and re-characterise 40 a transaction under § 6

35 “L’article 170bis LIR nouvellement introduit en 2001 traite des opérations de fusion […..] , impliquerait qu’il y aurait obligation que le bénéfice reste exposé à une imposition ultérieure au Luxembourg.” Winandy, (2003) p.12.

36 Art.171 Al.3 LIR. See http://www.guichet.public.lu/entreprises/en/fiscalite/developpement-restructuration/acquisition-societes/fusion/index.html#undefined! on 10.8.2013.

37 The conditions of indefinite loss carry forward und Art. 114 LIR are - the losses have not already been offset, - the company has maintained proper accounting during the loss making period and, - the losses are off-set by the company that incurred them.

38 See Beltjens, p.436 regarding the options for fiscal unity utilization of losses for group companies. In addition, where the entity might have unrealized gains on assets, it could sell these to the receiving entity just before the merger and – as all transactions in Luxembourg are required to be conducted at arms length – realize the gain which could then be set off against its existing losses, see Beltjens p.438.

39 The ability to continue using losses following a change in shareholder rather than a merger has been confirmed in 2010 by the Administrative Court of Luxembourg (CAA, 15 July 2010, no.25957c) which upheld a decision by the Administrative Tribunal (TA, 6 July 2009, no.23982) confirming that tax losses can not be carried over if the company has been solely bought for exploiting pre-existing tax losses . An administrative circular (Circular no. 114/2 LIR of 2 Sept 2010) confirmed the right to carry forward losses in case of changing shareholder as long as economic activities are continued or even extended.

40 Transactions are analyzed based on their substance, rather than their chosen legal form, where there might be a divergence between the two. See IFA Cahiers 2011, vol.96a p. 476 referring to IFA Cahiers 2010, vol. 95a p.490.


Steueranpassungsgesetz (“StAnpG”)41. The ‘Mantelkauf’ theory is also applied in

Luxembourg where the authorities suspect a new shareholder has simply bought an

empty shell company with losses.

3.3.3 United Kingdom

A company will be subject to tax in the United Kingdom (“UK”), if it is resident42

there. Tax is levied on the company’s profits, which consist of its income and

chargeable gains (i.e. the capital gains). This differentiation also drives the different

sources of UK tax law most relevant to corporate restructurings - the Corporation

Taxes Act (2009) (CTA 2009) and the Taxation of Capital Gains Act 1992 (TCGA

1992).43

As established, the UK has no codified rules in corporate law for legal entity

restructurings; hence the taxpayer must look to a number of provisions in tax law to

understand the potential impact of a group merger. The Taxation of Capital Gains Act

(TCGA) 1992 s.139 allows for the transfer of a business, or part of a business, from

one company to another under a scheme of reconstruction at a tax value that results in

neither a gain nor a loss.44

Merger relief45, a roll over deferral for Capital Gains Tax, is available for a merger by

share exchange as long as certain holding thresholds46 are met. Internal transfers of

41 In addition to the general tax provision of the Abgabenordnung (“AO”) dealing with procedural aspects of direct taxes, the StAnpG sets out particular principles of tax law. See Steichen (2013) pp.2 et seq.

42 The UK’s residency rules are twofold, either by the company being incorporated in the UK or by having it central management and control in the UK if it is incorporated elsewhere.

43 Tax liabilities arising after the restructuring might be covered by Taxation (International and other Provisions) Act 2010 (TIOPA 2010) and Income and Corporation Taxes Act 1988 (ICTA 1988).

44See http://www.hmrc.gov.uk/manuals/ctmanual/ctm47410.htm on 15.5.2013. If the conditions are met, then the provision applies mandatory unless the main purpose is the avoidance of tax. If the assets are transferred in exchange for shares followed by liquidation, again a tax deferral is available until the ultimate sale of the assets under TCGA 1992 s. 140.

45 See Harris (2013), p.538. Also see IBFD (2003), p.29 “The tax legislation of the UK does not contain a provision providing for rollover relief for assets and liabilities transferred in the case of a merger by acquisition of a company resident in the United Kingdom and a company resident in another Member State.”


assets within a capital gains group can also be achieved under the group relief rules

resulting in the ‘porting’ of the historic book cost and any capital gain only being

realized upon sale outside of the group as long as no exit from the UK tax system

occurs.47

Losses can not only be offset within the group, but also carried back or carried

forward. A company can carry most losses forward with no time limitations, subject

to a ‘quality’ limitation resulting from the UK schedular system of taxation - losses

can only be offset against future profits of the same trade48 by the same legal entity.

Recently, a GAAR rule has been introduced in the UK49, which might significantly

change the current position. To date no substance over form doctrine was enshrined in

domestic legislation and only a range of targeted provisions (“TAAR”) and case law

had developed a system where transactions could be recharacterised if found to be

solely structured to obtain a tax advantage.50 In general, genuine and commercially

46 See Harris (2013), pp.542 et seq. Scenarios allowing for merger relief are a) the receiving entity holds in excess of 25% or ordinary share capital of the transferring entity, b) the receiving entity made a general offer to the shareholders of the transferring entity and c) post merger, the receiving entity holds ‘the greater part of the voting power’ in the transferring entity. See TCGA 1992 s.135 and 137, s.138 for clearance procedure available. However see Harris (2013), pp.547 et seq for the potential issues in valuing the shares and assets appropriately.

47 See TCGA 1992, s.171 allowing transfers between UK tax resident members of the capital gains group on a no gain/no loss basis and entitles the receiving entity to inherit the historic acquisition cost of the asset. There is an ongoing discussion whether the rules in s.171 conform with EU law due following the ECJ’s decision in X and Y v Riksskatteverket (C-436/00).

48 CTA 2010, s.45 (1)-(6). See Green, Newby, Sarson (2011) p.737 for a review of circumstances and case law where losses cease to be available.

49 On 17th July 2013, the Finance Bill 2013 received Royal Ascent to become the Finance Act 2013 and introduced a GAAR into UK legislation. HMRC in its guidance note however make it very clear that its intention is to ‘change the game’ and deter taxpayers from entering into abusive arrangements, the guidance paper states as the fundamental approach “It [the GAAR] therefore rejects the approach taken by the Courts in a number of old cases to the effect that taxpayers are free to use their ingenuity to reduce their tax bills by any lawful means, however contrived those means might be and however far the tax consequences might diverge from the real economic position.” It is yet unproven how such this will influence what are perceived to be abusive arrangements and profit shifting activities and upcoming decisions by the courts.

50 See line of argument from Duke of Westminster v CIR [1936] AC1 where the court refused to look a substance over form but respected the legal form chosen and its tax results (“Every man is entitled if he can to order his affairs so that the appropriate Act is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow tax payers may be of his ingenuity, he cannot be compelled to pay an increased tax.”, Lord Tomlin) to Lord Wilberforce introducing the concept of ‘circular’ schemes of tax avoidance in W T Ramsay Ltd v IRC ([1981] STC 174) and establishing the ‘Ramsay principle’. The Ramsay principle got extended beyond circular transactions to a scheme of tax deferral in Furniss v Dawson ([1984] STC 153).


motivated cases of business restructuring should not be considered artificial. Anti-

abuse provisions under TCGA 1992 s.137 mean that merger relief is not available if

the transaction forms part of a so-called ‘scheme’ and one of its main purposes is to

avoid tax51. Specific anti-abuse provisions are included in the corporation tax rules to

prevent the utilization of losses incurred by an unconnected company, eliminating

certain cases of trading in loss companies.52

3.4 Common Themes and Potential Problems

The amalgamation of two corporations into one corporation is governed by different

rules in each of the three countries, both under corporate and tax law. Where these

rules foresee a legal merger scenario, one expects to see a coherent system and

symmetry in the tax treatment.

Merging two companies and achieving tax neutrality in a domestic scenario can be

achieved in all three jurisdictions, albeit through different mechanisms. In Austria and

Luxembourg, corporate law recognizes the concept of a legal merger and tax rules

allow tax neutrality for assets and liabilities under certain conditions where the

merged company ceases to exist. By contrast, in the UK a business combination

requires more complicated arrangements. Corporate law does not foresee a special

procedure for a merger and hence the tax treatment depends on which surrogate is

chosen. Roll over relief in Austria and Luxembourg for mergers and in the UK for

51 See HMRC Manual CG 52670, http://www.hmrc.gov.uk/manuals/cgmanual/cg52670.htm on 20.5.2013. HMRC as executive authority does neither write law nor does it generally issue binding rulings. Their current view can be deducted from publicly available HMRC manuals and handbooks and will give guidance as to interpretational freedom of the law. “As well as the legislation contained in the taxes Act and statutory instrument, the UK government also issues statements of practice (SPs) and extra-statutory concessions (ESCs), outlining the approach of HM revenue and Customs (HMRC) in relation to unclear or complex areas of legislation.” See Green, Newby and Sarson, p.731.

52 CTA 2010, s.719 (2), (3), CTA 2010, s.673 (1)-(3) and HMRC Statement of Practice 10/91. Broadly, these require the original trade to be continued, losses to the original trade to be ring fenced as well as continuity in the ownership of the trade.


share exchanges is provided as long as the jurisdiction maintains the ability to tax any

latent gains at a future point in time.

Over and beyond the transfer of assets at historic cost, the availability of losses

becomes the most interesting subject for discussion. Looking at the wider context in

the EU, only three countries (Denmark, Italy and Austria) allow crossborder offset of

profit and losses53. Nine EU members have no concept of group taxation and the

remaining have a more or less generous concept of offsetting losses and profits like

the UK and Luxembourg when taxing each entity separately under the concept of

legal personality that are not in principle consolidated.

Austrian companies have the most generous tax group regime under § 9 KStG where

even foreign losses can be offset. In Luxembourg, a tax consolidation regime allows

for the offsetting of losses with profits within the same group as long as the parent

company is fully taxable in Luxembourg and holds at least 95% of the share capital of

its fully taxable Luxembourg consolidated subsidiaries54. Austria and Luxembourg

have “change of ownership” rules to limit the amount of losses transferred and trigger

forfeiture if the subsidiaries losses in upon significant change in business activities or

ownership. The UK has no system of group consolidation55, it does however allow

certain current year losses incurred by one company to be set off against the profits of

53 See BMF, p.19. A recent report by the Federal Audit office (‘Bundesrechnungshof’) has highlighted that the generous crossborder group taxation regime resulted in EUR 3bn of foreign losses being offset in Austria and EUR 0.5bn foreign loss carry forwards being claimed against Austrian income. As Austria does not have any ability to tax foreign income, it is questionable whether any other countries would want to follow the example of the extended cross border tax grouping at such a high cost. The counter argument, and the argument the Ministry of Finance is putting forward, is that the generous group taxation rules in Austria have resulted in increased number of multinational companies relocating their headquarters and hence additional tax revenues. As no exact numbers are available this will remain an area for debate and political decisions.

54 Art. 164 LIR, this tax consolidation only covers corporate and commercial income tax. Also see http://www.guichet.public.lu/entreprises/en/fiscalite/developpement-restructuration/acquisition-societes/fusion/index.html#undefined! on 10.8.2013.

55 Each company is required to compute their profits and tax liability on a single entity basis.


a group company under certain conditions, known as group relief.56 Members of a

75% owned group are able to offset trading losses 57 against profits in group

companies in the same period avoiding the disadvantage of establishing group

companies compared to setting up branches, which are automatically consolidated.58

In crossborder settings, the ability to use losses of merged companies is often

restricted. Losses can become ‘stranded’ in a country where they are inaccessible and

no access to relief in the taxpayer’s state of residence. This may put companies in an

unfavourable position compared to a mere domestic setting by resulting in a total tax

burden exceeding the actual profits and its economic capacity59 to pay taxes. The

shortcoming in domestic legislation only relieving losses form the state of origin

constitutes a barrier to accessing other markets. As such these do not conform to the

guiding principle of the European Union – the establishment of a functioning internal

market.

At the same time, provisions too generous can also contravene EU law. The domestic

rules allow for the Austrian parent to utilize foreign losses in the period in which they

are incurred, if they cannot be offset abroad. Such loss utilization is subject to a claw

back, if the losses can be used in the foreign state in the future then Austria retains the

right to ‘make up’ payments. The ECJ’s case law has shown in its decisions on final

56 Also see Marks & Spencer plc v. Halsey (December 2005) for a successful challenge to the group relief rules and the subsequent extension of domestic group relief rules in 2006. A UK case, Electronics v Inspector of Taxes [2005] S.T.C. (S.C.D.) 512, discusses the issue of setting of terminal losses of two of its divisions against prior year profits, testing the question whether these where separate trades. Also, cross border loss surrender is not possible where the loss to be surrendered has been partially deducted from the non-residents tax liability, see Philips Electronics (C-18/11).

57 Trading losses, excess capital allowances and non-trading deficits on loan relationships may be surrendered in full, irrespectively of whether the transferring company has other profits, which might have been offset. See http://www.hmrc.gov.uk/manuals/ctmanual/CTM80110.htm on 10.8.2013.

58 See ICTA88/S403 (1), (2) and (3). The group relief rules are different for income and capital gains tax and some important limitations apply, in particular re capital losses.

59 See also Cohrs (2013).


losses that it does not consider the Austrian loss utilization rules in § 9 Abs.6 Z6

KStG compliant with EU law.

4 EU LEGAL FRAMEWORK FOR MERGERS

4.1 EU Law

Under the Treaty on the Functioning of the European Union (“TFEU”)60 national

rules must comply with EU law to support the internal market. EU Directives provide

a framework and the desired outcome but leave form and method of achieving these

to the member state.

In tax law, generally only indirect taxes are harmonized61 as they impact the free

movement of goods and the freedom to provide services. Direct tax laws remain the

sole responsibility of the Member State62, a reserved but not unlimited competence,

which only applies within the boundaries set by EU law63. National rules create a

restriction, when they implement measures that “[…] prohibit, impede or render less

attractive the exercise of that freedom”64. The TFEU articles concerning the free

movement of goods, persons, services and capital (the four ‘fundamental freedoms’)65

have direct effect for national law. The questions referred to the ECJ ordinarily

60 C 83/51 as updated in 2010, see http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:0047:0200:en:PDF on 11.8.2013.

61 Under Art. 113 TFEU “The Council shall, acting unanimously in accordance with a special legislative procedure and after consulting the European Parliament and the Economic and Social Committee, adopt provisions for the harmonisation of legislation concerning turnover taxes, excise duties and other forms of indirect taxation to the extent that such harmonisation is necessary to ensure the establishment and the functioning of the internal market and to avoid distortion of competition.“ See also Council Directive 2008/7/EC of 12 February 2008 concerning indirect taxes on the raising of capital and Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, as amended over time.

62 In the absence of a specific provisions, Art. 115 TFEU is seen to be the most appropriate legal basis for possible EU wide harmonization in the area of direct tax.

63 See AG Maduro’s opinion on Mark & Spencer at para. 4 for the role of the ECJ and the statement of the ECJ in its Schumacher (C-279/93) judgement at para. 21.

64 See AG Maduro’s opinion on Mark & Spencer at para. 35.

65 The fundamental freedoms are: 1.Free movement of workers Art. 45 TFEU, 2. Freedom of establishment Art. 49-55 TFEU, 3. Freedom to provide services Art. 56 TFEU, and 4. Free movement of capital Art. 63 TFEU.


concern discussions whether a restriction imposed by the Member State engaged any

of the fundamental freedoms. Following an array of case law66, it is now a generally

accepted doctrine of Community Law that cross-border mergers in Europe 67 are

protected by the fundamental freedom of establishment68. Alternatively to switching

on the fundamental freedoms, group mergers across jurisdictions also might fall under

the Merger Directive and invoke EU law through that route.

As established earlier in this paper, domestic tax rules often lack with respect to

crossborder mergers. This creates uncertainty and leads to cross border

reorganizations being frequently discussed in the European courts and referred to the

ECJ. In the functioning internal market, a company should have the choice as to

whether it incorporates a subsidiary domestically or in another member state. When

merging a subsidiary69, often it will be in a loss making position or have historic

losses and hence be considered for closure. The ability to use such losses is critical to

the surviving group companies.

66 See Cohrs 2013 for a formidable review of the case law.

67 See Mindpearl AG v HMRC [2011] UKFTT 555 (TC) for a decision, where a Swiss company which had claimed loss relief under the Income and Corporation Taxes Act 1988 s.343 based on the trading losses of its predecessor could not argue that the 75 per cent requirement under s.343(1)(a) was contrary to EC Treaty (Nice) art.43, now Article 49 TFEU, as that provision only applied to transactions between nationals of Member States.

68 Under Art. 49 TFEU, as extended to companies by Art. 54 TFEU. See discussion in Chapter 5 for analysis of recent case law.

69 This also applies to the establishment of a domestic branch versus a cross border Permanent Establishment. For relevant case laws see Deutsche Shell GmbH v. Finanzamt für Grossunternehmen in Hamburg (C-293/06) and Krankenheim Ruhesitz (C-157/07) which both concerns final losses of a foreign PE, whereas Lidl Belgium (C-414/06) concerns ongoing losses of PE.


4.2 The Merger Directive

National Rules on group restructurings have been shaped by the Merger Directive70,

which aims71 to abolish tax obstacles on cross-border reorganisations. The scope72 of

the Merger Directive is very prescriptive – it applies to cross border mergers between

companies resident in European Union member states 73 (“Member States”). The

Merger Directive allows the merger of business operations without triggering

immediate capital gains tax and puts cross border mergers on an equal footing to most

domestic systems of tax neutral reorganisations74. The Merger Directive also aims to

protect the financial interests of the Member States and sets out to protect the taxing

rights through the requirement for a permanent establishment to remain (Art.4 Merger

Directive)75.

Loss transfers are stipulated in Art. 6 Merger Directive. The rules only apply if the

member state has domestic rules providing loss transfer for unutilized losses

connected to the transferring branches/activities to the receiving company76. The loss

offset rules of the receiving company’s country are not covered in the Merger

Directive. This light touch, together with requirement of Art.4, results in the loss

70 See Lang, Pistone, Schuch, Staringer p.24.

71 See Preamble (2) and (3) of the Merger Directive.

72 See Art. 2 (a) Merger Directive, also Lang/Pistone/Schuch/Staringer p.136.

73 As of August 2013, 28 states have joined the EU, for up to date information see http://europa.eu/about-eu/countries/member-countries/.

74 Basically this is achieved by granting a roll-over of the balance sheet values under Art.4 Merger Directive. Also Helminen (2011) at p.172 gives a good overview of the Merger Directive and its goals.

75 See Lang/Pistone/Schuch/Staringer p.140 regarding this requirement seen as ‘claim saver’ for the future realization of any capital gains and the continued right of the member state to tax such gain. The usefulness of this requirement and the ECJ’s discussion on exit taxes are outside the scope of this paper.

76 Note discussion in Helminen (2011), p.173 “In conclusion, the Merger Directive requires the deferral of capital gains taxation if a permanent establishment is left in the state of residence of the merging company. The Merger Directive, however, does not require the state of residence of the receiving company to deduct losses of the merging company even if a permanent establishment would be left in the state of residence of the merging company. It then depends on the basic freedoms of the TFEU to what extent the state of residence of the receiving company is required to allow a deduction for the losses of the merging company.”


transfer rule being considered only a non-discriminatory rule, which is not often

triggered on its own, and hence rendering it, in the eyes of some academics,

obsolete.77

Anti-abuse provisions are included in the Merger Directive in Art.15 (1) (a)78 and

allow the Member States to withdraw the benefits of the Directive where tax evasion

or abuse is present.

As no definition of tax evasion or avoidance is given in the text of the Directive,

Member States when implementing the Directive into national law are able to

translate these concepts as they see fit. The ECJ had to consider a number of cases on

the interpretation of Art. 15 (1) (a) Merger Directive79.

4.3 The Procedure

Where national rules do not comply with the TFEU, the view of the ECJ can be

sought80 by a national court or a Member State or indeed referred by the Commission

77See Lang/Pistone/Schuch/Staringer p.142.

78 Art. 15 Merger Directive: “1. A Member State may refuse to apply or withdraw the benefit of all or any part of the provisions of Articles 4 to 14 where it appears that one of the operations referred to in Article 1:

(a) Has as its principal objective or as one of its principal objectives tax evasion or tax avoidance; the fact that the operation is not carried out for valid commercial reasons such as the restructuring or rationalization of the activities of the companies participating in the operation may constitute a presumption that the operation has tax evasion or tax avoidance as its principal objective or as one of its principal objectives.”

79 See Leur–Bloem (C-28/95) and Kofoed (C-321/05). In Zwijnenburg (C-352/08) the ECJ clarified that only taxes to which the benefit of the Merger Directive relate are considered when looking at the motivation of a transaction and tax avoidance.

80 Under the preliminary ruling procedure, a national court requests a ruling on an actual case to clarify the interpretation of the TFEU, whereas in an infringement procedure, a community institution or a member state bring proceedings against another Member State. Member State rights in Art. 265 TFEU. Commission rights in Art. 258 TFEU see Avoir Fiscal (C270/83) for an example where the Commission investigated member state rules. Art. 267 TFEU, for the entitlement and the requirement for submission by national court, also Lutz GmbH and Others (C-182/00) para. 13 for more insight. Requests for preliminary rulings are subject to the ‘Acte Clair’ Doctrine, under which question should not be asked if the interpretation is unambiguous, see CILFIT (C-283-81) para. 21“unless it has established that [...] the community provision in question has already been interpreted by the court so that the correct application of Community Law is so obvious as to leave no scope for any reasonable doubt”.


itself as a proxy for direct harmonization81. The taxpayer has no right to refer to the

ECJ directly. In analyzing any case, the ECJ will firstly identify which of the four

‘fundamental freedoms’ is at stake and then proceed to test whether there was

discrimination 82 on grounds of nationality or a restriction 83 . Before reaching a

conclusion, the ECJ needs to take into account whether the restriction pursues an

objective compatible with EU law. Member states have the opportunity to present

justifications 84 and finally the rules are reviewed for proportionality 85 . If a

justification is not accepted and rules are not found to be proportional, then they are in

conflict with EC law.

4.4 Conclusion

Direct taxation is neither specifically regulated under EU law nor harmonized across

Member States. This uncertainty combined with the requirement for national rules to

comply with the TFEU creates an area requiring guidance both for the taxpayer as

well as the domestic legislator. The case law of the ECJ is helping to establish the

81 See Art. 115 TFEU, which provides a proxie for a EU provision for legislative competence in the area of direct taxation. “Without prejudice to Article 114, the Council shall, acting unanimously in accordance with a special legislative procedure and after consulting the European Parliament and the Economic and Social Committee, issue directives for the approximation of such laws, regulations or administrative provisions of the Member States as directly affect the establishment or functioning of the internal market.”

82 Art. 16d TFEU. Both direct and indirect discrimination on grounds of nationality are prohibited. See Schumacker (C-279/93) para. 30 for a definition of discrimination. The ECJ states in Imperial Chemical Industries Plc v Cromer (C264/96), para. 16, “[…] the legislation at issue limits, or at least discourages, the exercise by British companies of the right to create corporate structures in other Member States […]”.

83 See Dassonville (C8/74) for development of the definition started in Avoir Fiscal (C270/83), that can be paraphrased as “hinders, deters, makes less attractive the exercise of fundamental rights”. In Dassonville the Court held that trading rules that could hinder intra-EC trading contradict the then Art. 28 ECT, Art. 34 TFEU. Also Futura (C-250/95) and Krankenheim Ruhesitz am Wannsee-Seniorenheimstatt GmbH (C-157/07). Helminen (2011) discusses the circumstances constituting restrictions, p.174, and gives a brilliant overview of the possible justifications, pp.175 et seq.

84 Treaty Justifications under TFEU are limited to public policy, security and health for the freedom of establishment, Art. 52 TFEU, and public policy & security for the free movement of capital, Art. 66 TFEU. See Cassis de Dijon (Case 120/78) para. 8, Keck and Mithouard (C267 and C-268/91) para. 15. Justifications that have been accepted in case law include a) coherence of tax system (in Danner (C-136/00), also accepted in Bachmann (C-204/90) but has since been mainly rejected by the ECJ), b) prevention of tax avoidance (in Cadbury Schweppes (C-196/04)), c) balancing allocation of taxing rights (in Marks & Spencer) and d) ensuring effective fiscal supervision (in Marks & Spencer). Discussion in O’Shea 2006 pp.70-81. Economic reasons including protection of tax revenues have not been accepted by the ECJ, see Vestergaard (C-55/98), also Gammie p.23. The so called ‘rule of reason’ or ‘Gebhard formula’ requires national rules to be a) non-discriminatory, b) meet the public interest requirement in its legitimate ECT-compatible objectives, c) be appropriate for meeting the objective and d) are proportional and do not go beyond what is necessary to achieve the stated objectives, i.e. no less-restrictive means could be utilized to protect the public interest. See also O’Shea 2006 p.69 et seq. and Kofler p.27 et seq.

85 Gebhard (C-55/94) para. 37, see Futura for ECJ finding national rule disproportionate. Also O’Shea 2006 p.81 on Marks & Spencer.


boundaries of domestic rules to ensure they remain within what is required to ensure

the functioning of the internal market. This allows companies to remain competitive

and adapt to the requirements of the common market. The ability of the Court to

provide general guidance in specific circumstance is very important. This is further

illustrated by certain cases becoming landmark decisions that are referred backwards

and forwards by the national courts to extract the most precise answer possible.

5 ECJ CASE LAW ON LOSS UTILISATION

To understand the effect of EU rules on national merger laws, relevant EU case law

needs to be considered to see how the ECJ applies the rules of the TFEU and the

Merger Directive.

5.1 ECJ cases on cross border loss utilization in group mergers

The ECJ’s view on cross border losses has evolved from its 2005 landmark decision

in Marks &Spencer (C-446/03)86 when it held that cross-border group relief should be

possible under certain - very specific – conditions in cases of liquidating foreign

subsidiaries. Subsequent cases have shed additional light on the system national

legislators and court should act within. In no other cases until A Oy (C-123/11) has

the ECJ accepted cross border loss consolidation in its judgement.

86 This case had been decided in the UK Courts on 17 December 2002 (Marks and Spencer plc v Halsey [2003] STC (SCD 70), was appealed to Park J, referred without judgement to the ECJ where it became case C-446/03. On its return to the UK court, Park J provided his view on the ECJ judgement 2006 ([2006] STC 1235). Again this was appealed and cross-appealed to the Court of Appeal, its judgement obtained in 2007 ([2008] STC 526) and returned to First Tribunal under John F. Avery Jones and Macolm Gammie in February 2009 ([2009] UKFTT 64 (TC)) to find the facts in accordance with the Order of Park J as varied by the Court of Appeal. The First-tier Tribunal substantially confirmed the claims by Marks & Spencer for EU group relief claim to be valid.


5.1.1 Marks & Spencer

5.1.1.1 The facts of the case

Marks & Spencer plc., the parent company of the Mark & Spencer group and itself

resident in the UK, had a number of non-resident subsidiaries across the EU.

Following several years of unsuccessful trading, it decided in March 2001 to

terminate loss-making activities and liquidate its subsidiaries in Germany and

Belgium. As these subsidiaries were not resident in the UK and did not maintain a

permanent establishment in the UK, they were not in scope for the UK group relief

rules. The UK national provision for its group relief system was only available to UK

resident companies or UK permanent establishments of non-resident companies.

Between 2000 and 2008, Mark & Spencer applied for group tax relief for losses

incurred by its non-resident subsidiaries in line with what would have been granted

for resident entities87. After being refused such relief by the Revenue (“HMRC”),

Marks & Spencer argued that by denying its subsidiaries in EU member state the right

to surrender trading losses, the UK rules infringed its freedom of establishment88.

5.1.1.2 The ECJ judgment

The ECJ found that the right of freedom of establishment also requires the Member

State of Origin to not hinder the establishment in another Member State89 . “The

exclusion of such an advantage in respect of the losses incurred by a subsidiary

established in another Member State which does not conduct any trading activities in

the parent company’s Member State is of such a kind as to hinder the exercise by that

parent company of its freedom of establishment by deterring it from setting up

87 See Marks & Spencer (C-446/03) at para. 24. The amounts were substantial, with the losses in the German and Belgian entities – at the time- amounting to £99m, or a £30m reduction in tax.

88 Under Arts. 43 and 48 of the EC Treaty.

89 See Marks & Spencer (C-446/03) at para. 31.


subsidiaries in other Member States.” 90 UK Group relief rules were limited to

companies resident in the UK and hence made it less attractive to establish

subsidiaries outside of the UK, an exit restriction for UK resident companies entailing

unfavourable treatment for companies setting up subsidiaries abroad91.

The UK submitted a number of justifications for its restrictive national rules92. The

ECJ’s analysis of the justifications in its judgement extends the justification of the

coherence of the tax system established in Bachmann (C-204/90). AG Maduro in his

opinion on Marks & Spencer emphasizes the protection of the integrity of national

rules, only for so long though as they do not create an impediment to the integration

to the internal market 93 . The ECJ did, for the first time, accept a threefold

justification94 put forward by UK - the prevention of double counting of losses95 and

tax avoidance96 was accepted ‘taken together’ with the preservation of the taxing

powers as justification. The decision in Marks & Spencer introduces the argument of

‘preserving the balanced allocation of taxing powers between Member States’ to the

ECJ vocabulary. This was the first time that the Court accepted that the aggregate of

these justifications weights more than the sum of its parts and found the restriction to

be justified.

However, all national rules need to be proportional and any restriction should not go

beyond what is necessary to achieve a desired outcome. The ECJ regarded the UK’s


91 See AG Maduro in Marks & Spencer (C-446/03) at para. 53.

92 See Mark & Spencer (C-446/03) at para. 42 et seq.

93 See AG Maduro in his opnion on See Mark & Spencer (C-446/03) at para. 66.

94 The concept of territoriality was rejected by the Court in Marks & Spencer (C-446/03) at para. 40. The loss of tax revenue was not accepted as overriding public interest justification (para. 44), the preservation of taxing power power however was (para. 45).

95 See Marks & Spencer (C-446/03) at paras. 47-48.



domestic rules to go beyond what is necessary to attain the objective pursued97 with

regards to final losses only. The Court provides a first set of criteria98 what final

losses are; losses are thus exhausted where the following cumulative requirements are

met99:

- the possibilities for foreign loss set off have been exhausted, including carry back

to previous periods

- no further utilization can be expected in the foreign jurisdiction at any point in the

future, either by the subsidiary or a third party,

Where these conditions are met, the ECJ ruled that the freedom of establishment

prevails over any potential justifications and the state of origin must allow the

deduction of final losses for non-resident subsidiaries where it has comparable rules

for resident entities.

5.1.1.3 The Marks & Spencer legacy - The final losses doctrine

The landmark decision in Marks & Spencer has for the first time given guidance to

Member States as to what extent non-resident losses may impact the domestic result

for taxes. Numerous countries commented in the judgment and were very concerned

by the potential requirement to amend their legislation and accept potential reduced

tax revenues. The ECJ’s judgement has clarified that in general Member States are

not required to take non-resident losses into account unless there are final and

comparable rules allow resident losses to be taken into account. This ‘final losses’

doctrine results then in an obligation for Member States to take into consideration

97 The principle of proportionality, see Marks & Spencer (C-446/03) at para. 35, the conclusion that the UK group relief rules are not proportionate are in para. 55 of the judgement.

98 In its X Holdings judgement, the ECJ has evoked increased doubt as to whether even final losses need to be considered. See AG Kokott’s Opinion on A Oy (C-123/11), para. 47-54.

99 See Marks & Spencer (C-446/03) at paras. 55-56. The ‘no possibilities test’.


losses of foreign subsidiaries, where any possibility for deducting the loss in the host

state has been exhausted and no potential future use by the foreign subsidiary appears

possible.

The debate remains open as to the difference between a factual impossibility and a

judicial impossibility. The difference between factual and legal impossibility could be

where technically the tax rules allow a future offset however no entities remain in the

jurisdiction or the one remaining are themselves This continues to be discussed in the

national courts100. The assessment whether losses are final is ultimately a question for

the national courts to decide. The ECJ has explicitly stated the Member States right to

introduce specific anti-abuse provisions targeted at avoiding the national rules101 .

Already, the ECJ’s decision has resulted in a significant change to the UK rules. Also,

the decision has been seminal for subsequent case law102 and remains one of the most

prominent judgements of the ECJ in the area of direct taxation.

5.1.2 A Oy

The ECJ decided for the taxpayer in in A Oy (C-123/11) and examined cross border

relief of final losses in a group merger with a foreign subsidiary. As the Merger

Directive is silent on “the question to which extent the state of residence of the

receiving company must allow a deduction of the losses of a merging company in an

100 See decision of 16 June 2011 (6-K-445/09) of the Lower Court of Niedersachsen, requiring a factual impossibility in determining the final nature of losses. The focus in UK jurisprudence has been on the legal possibility of using the losses not on the factual possibility. See Bologne/Slavnic at p.7 “In the authors’ view, it follows from Krankenheim Wannsee that M/S P [Member State of Parent, addition by author] should only be obliged to allow for a deduction of the losses incurred in M/S S [Member State of Subsidiary, addition by author] if these losses also qualify as “final losses” according to the tax rules of M/S P.”


102 Oy AA (C-231/05) and X Holdings (C-331/08) are cases dealing with on-going losses of foreign subsidiaries.


intra-EU cross-border merger.”103 , the ECJ’s decision in A Oy has been ground

breaking in its potential requirement for Member States to adapt its taxation laws and

apply the Marks & Spencer “final losses” doctrine in a merger scenario.


On March 7th 2011, the Supreme Administrative Court of Finland referred case KHO

2011/547 (21) to the ECJ for a preliminary ruling. The case concerns an appeal from a

Finnish parent company limited by shares, A Oy, regarding a binding advance ruling

of the Central Tax Board of Finland (‘Keskusverolautakuna’ (KVL)) regarding the

upstream merger of B Ab, a Swedish subsidiary of A Oy. The national Finnish rules

provided for the right of the acquiring company in a domestic merger to deduct losses

if it owned more than 50% in the subsidiary at the beginning of the year in which the

losses were incurred. Under Finnish rules (the Finnish Act on Business Taxation

(Elinkeinoverolaki), “EVL”, and the Finnish Income Tax Act (Tuloverolaki), “TVL”),

losses could only be deducted in Finland, if they were determined in accordance with

the EVL, the losses of B Abs however had been calculated in line with the Swedish

tax rules and amounted to 44.8m SEK (approx. 5.2m EUR) from the years 2001-7. As

the loss was not based on EVL and TVL, it was not taken into account for the Finnish

tax calculation. There was no indication that the merger was solely motivated by

tax104.


The ECJ held in favour of the taxpayer and confirmed that the Marks & Spencer

doctrine of “final losses” can be invoked to offset losses of a non-resident transferring

103 See Helminen 2011, p.172.

104 See A Oy (C-123/11), para. 17.


company in a merger. The national rules stipulated a loss transfer for the receiving

company105 in a domestic merger but not for a cross border merger, the freedom of

establishment was invoked and a restriction found. The losses were considered to be

‘final’ as the only other group companies in Sweden were themselves loss making106.

No possibility of loss set-off was to be expected107 and no indication of tax avoidance

was given.

AG Kokott found that the restriction could be justified by the balanced allocation of

taxing powers108 and found the Finnish rules ‘reasonable proportionate’109. The ECJ

disagreed and found the restriction not justified. As a result, the Finnish parent

company (A Oy) could deduct the unutilized pre-existing operating losses in Sweden

through an upstream merger of its fully owned Swedish subsidiary (B Ab).110 The

Merger Directive was deemed not to be applicable by both the Advocate General

Kokott 111 and the ECJ 112 as no permanent establishment of A Oy remained in

Sweden113, the judgement confirmed that the freedom of establishment can go further

105 See A Oy (C-123/11), para. 30. See X Holdings (C�337/08), para. 17 for the applicability of the freedom of establishment also to companies, “Freedom of establishment, which Article 43 EC grants to Community nationals and which includes the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, under the same conditions as those laid down for its own nationals by the law of the Member State in which such establishment is effected, entails, in accordance with Article 48 EC, for companies formed pursuant to the law of a Member State and having their registered office, central administration or principal place of business within the European Community, the right to exercise their activity in the Member State concerned through a subsidiary, a branch or an agency (see, inter alia, Case C-307/97 Saint Gobain ZN [1999] ECR I6161, paragraph 35, and Marks & Spencer, paragraph 30)”

106 See A Oy (C-123/11), para. 11.

107 No signs of using losses twice were obvious, see A Oy (C-123/11), para. 44.

108 See AG Kokott’s Opinion on A Oy (C-123/11), para. 54.

109 See AG Kokott’s Opinion on A Oy (C-123/11), para. 68.

110 See A Oy (C-123/11), para. 9.

111 In her opinion as published on 19/07/2012, see http://curia.europa.eu/juris/document/document.jsf?docid=125201&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&cid=83515 on 11.8.2013.

112 See judgement at http://curia.europa.eu/juris/document/document.jsf?text=&docid=134107&pageIndex=0&doclang=en&mode=lst&dir=&occ=first&part=1&cid=5684992 on 10.8.2013

113 The remaining group companies, Y AB and Z AB, were subsidiaries of another group company, X Oy and not directly owned by A Oy. See Art.4 & 6 Merger Directive and A Oy (C-123/11), para. 10.


than the Directive. With respect to the rules for determining the amount of the tax

reduction, the ECJ has given limited guidance in A Oy, as it stipulates that the

calculation should reflect equal treatment compared to that of the equivalent entity in

a domestic situation, the resident subsidiary114, which indicated that the rules of the

origin state where the receiving entity is resident should be applied. This judgement

will require national courts to determine the relevant losses on a case-by-case basis.

5.1.2.3 A Oy - The impact on future case law

The ECJ judgement in A Oy provides useful clarity for Member States as to their

requirement to align merger loss utilisation rules for domestic and cross-border

mergers. It also clarifies that Member States need to provide loss utilization rules for

one-off losses stemming from mergers not only from liquidations and potentially

similar circumstances. From its deliberations, it becomes evident that where internal

mergers benefit from loss relief, cross-border mergers in a comparable situation need

to have access to the same rules. Many questions though remain open - whether losses

that only exist under the rules of the host state and are due to timing differences need

to be taken into account into the state of origin, or whether the amount of the losses

should be only be determined under the rules of the origin state. These questions are

relevant as in the frequently used words of the ECJ: ”freedom of establishment cannot

[…] be understood as meaning that a Member State is required to draw up its tax

rules on the basis of those in another Member State in order to ensure, in all

circumstances, taxation which removes any disparities arising from national tax

rules.” 115 Further ECJ cases are to be expected and will hopefully provide for

continuing clarification, maybe already in the pending K case (C-322/11).

114 See A Oy (C-123/11), para. 59.

115 Bologne/Slavnic citing Deutsche Shell (C-293/06) at p.6.


5.2 ECJ on Tax Avoidance for loss utilization in mergers

5.2.1 Foggia

The ECJ delivered its judgment in the preliminary ruling request by the Portuguese

Supremo Tribunal Administrativo (the court of final instance) in the Foggia (C-

126/11) case. Before even answering the questions referred, it had to establish its

competence to answer; the Portuguese Government had questioned the ECJ’s remit,

as the circumstances were purely internal116. The ECJ ruled that it had jurisdiction as

the tax rules for mergers applied both domestically as well as cross-border. In

particular where a term (“valid commercial reasons”), initially used in this context in

the Merger Directive, was used in national legislation, the ECJ found it important to

ensure a consistent interpretation.


In 2003 Foggia, a Portuguese resident taxpayer and member of a corporate group,

merged with three of its group companies in a merger by acquisition. The transferring

entities, three holding companies, were also Portuguese resident. Portuguese tax law

allows in a merger for the tax losses of the transferring entity to be offset against the

taxable profits of the receiving entity as long as such merger was entered into for

“valid commercial reasons” 117 . In order to deduct the unutilized losses of the

transferring entities and in line with the domestic legislation, Foggia applied to the

Ministry of Finance to set off losses by the three transferring companies incurred

116 See Foggia (C-126/11) at para. 16 et seq.

117 See Portuguese Corporation Tax Code (Código do Imposto sobre o Rendimento das Pessoas Colectivas, the “CIRC”), Art. 68-60 at Foggia (C-126/11) at paras. 6-7. Such restriction is in line with the requirements of the Merger Directive as the same conditions re put upon domestic and cross border transactions.


between 1997 and 2002. The taxpayer argued that the benefits from the group

restructuring were mainly derived from administrative and management cost savings.

Such application was denied for one of the companies (Riguadiana – SGPS SA,

“Riguadiana”)118 as no commercial interest was identified and abuse was suspected.

The local authorities suspected abuse as Riguadiana did not effectively carry out any

activities or generated any taxable income, but had invested in securities and no clear

provenance of its tax losses could be provided 119 . In its refusal, the authorities

explicitly stated that the reduction of administrative costs alone does not provide a

sufficient commercial rationale for a merger.


In the judgement on Foggia (C-126/10), the ECJ clarified that EU law would apply,

in accordance with settled EU case law where a domestic legislator employs an EU

law concept in internal law, such concepts should be interpreted uniformly by the

ECJ.

When discussing the questions referred by the national courts, the ECJ follows its

previous case law on “valid commercial rationale”120 and gives further insight into its

thinking on the then Art.11 (now Art.15) Merger Directive. Where tax avoidance is

one of the main objectives, Member States are able to withhold the benefits of the

Merger Directive121.

118 See Foggia (C-126/11) at para. 10. The request was approved for the other two companies.

119 See Foggia (C-126/11) at para. 11.

120 The ECJ describes tax avoidance in Cadbury Schweppes (C-196/04) as ‘wholly artificial arrangements’. See Zwijnenburg (C-352/08), also see Ionna Mitroyanni (2007), p.77 “The scope of the anti-abuse provision of the EC Merger Directive 212 has been interpreted in Leur-Bloem. The Court gave a strict literal interpretation of the anti-abuse clause. It ruled that, if the operation was not carried out for 'valid commercial reasons', there is a presumption of tax evasion or avoidance.“ Leur-Bloem (C-28/95)).

121 See Foggia (C-126/11) at paras. 3-5.


The ECJ recognises that tax considerations might be one of the considerations in a

group restructuring decisions, however clarifies that it should not be predominant.122

Further, a positive effect from a merger on administrative and management cost is to

be expected in a group simplification but in this case are too marginal to outweigh the

tax advantage as the main driver. In particular, the absence of any commercial

activities like actual holding activities rather than just investment in securities,

combined with a relatively large tax loss of EUR 2m of undefined pedigree, let the

ECJ conclude that the transaction had not been entered into for ‘valid commercial

reasons’123 and “the form of the transaction was that of a merger, but the merger was

not the real purpose of it, rather, the tax losses were”124.

After answering these questions, the ECJ referred back to the national courts’ remit to

decide whether a particular group restructuring intends to avoid tax as no

predetermines criteria can be relied upon.125

5.3 Resulting trends in ECJ case law

The criteria for final loss utilization have been set very tightly and will limit the area

of application to a specific set of circumstances as final losses can be considered one-

off occurrences in contract to general rules for loss utilization. Where those specific

circumstances apply, Member States will have to review their tax rules carefully. The

ECJ’s decisions on the freedom of establishment have significantly influenced the

122 See Foggia (C-126/11) at para 35.

123 This has been developed already in a number of cases following Cadbury Schweppes (C-196/04) and Halifax (C-255/02), i.e. in Leur-Bloem (C-28/95) and Zwijnenburg (C-352/08).

124 See Jimenez, p.11.

125 See Foggia (C-126/11) at para. 37.


UK’s rules on group and consortium relief and resulted in amendments to “permit a

non-UK-resident company in certain circumstances to surrender losses and other

amounts by way of group relief that are not attributable to a permanent establishment

it has in the UK.”126 The Austrian rules on loss carry over in merger situations require

not only transfer at historic cost (i.e. following the rules the transferring entity was

subject to) but also the assets and liabilities that incurred the losses to be present in

the receiving entity, in cross border situations, this might be rather difficult and might

either require further ECJ guidance or an adjustment of national rules.

The UK’s introduction of a GAAR with the related overriding statutory limit as to

what extent taxpayers can reduce their tax liabilities, mirrors the focus of the ECJ’s

jurisprudence and its focus on “valid commercial rationale”. As Foggia shows, the

ECJ’s judgement lead to a more uniform interpretation of common concepts and

might help to harmonize at least the small areas of direct taxation.

6 CONCLUSION

From the review in this paper, it can be concluded that all of the three jurisdictions

allow some sort of tax neutral transfer. The analysis found a wide spectrum ranging

from full domestic and EU group consolidation in Austria, a fiscal unity regime in

Luxembourg and a system of group loss transfer rules in the UK. Specific merger

taxation legislation exists in Austria and Luxembourg, whereas the UK has more

specific rules depending on the kind of income and the transaction chosen.

126 See Bramwell et al. at T5.1.1.


When reviewing the limited but very significant case law for intragroup mergers and

loss transfers, it becomes clear very quickly how relevant these decisions are for

national rules. Taking into account the main developments in EU case law to

understand the “final losses doctrine” and the ECJ’s emphasis on “valid commercial

reasons”, it can be demonstrated that there is a trend towards harmonization in the

area of direct tax. One could put to the ECJ that any member state not wanting to be

challenged for cross border merger issues, would best not have any rules for internal

mergers. In such a scenario, where no permanent establishment remains and the

Merger Directive does not apply, no requirement can be established under the

freedom of establishment. Such a stance however would serve neither the internal

market nor the domestic circumstances.

The underlying principles of the TFEU and the increasing connectivity of corporate

groups across Europe, will also further fuel an on-going need for balancing the

sovereignty of the Member States and the need for further harmonisation across the

Union. For the time Member States will maintain their right to determine the laws for

direct taxation in their territory and will have to find a way to do so that is compatible

with EU law as well as ensuring they remain an attractive location for corporates to

locate their headquarters.


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